Financial and Accounting Guide for Not-for-Profit Organizations

By John H. McCarthy, Nancy E. Shelmon and John A. Mattie

A completely revised and expanded edition of the nonprofit industry finance and accounting standard

Filled with authoritative advice on the financial reporting, accounting, and control situations unique to not-for-profit organizations, Financial and Accounting Guide for Not-for-Profit Organizations, Eighth Edition is recognized by professionals as the industry standard reference on not-for-profit finance and accounting. Prepared by the PricewaterhouseCoopers Not-for-Profit Industry Services Group, the book includes accounting, tax, and reporting guidelines for different types of organizations, step-by-step procedures and forms, and more. A new chapter on public debt has also been added.

• Presents the latest updates to regulatory reporting and disclosure changes in recent years
• Reflects the totally revamped and revised AICPA accounting and audit guide for not-for-profit organizations
• Addresses concerns of all nonprofit organizations, including health and welfare organizations, colleges and universities, churches and other religious organizations, libraries, museums, and other smaller groups
• Includes step-by-step procedures and forms, detailed explanations of financial statements, and a how-to section on setting up and keeping the books

Financial and Accounting Guide for Not-for-Profit Organizations, Eighth Edition is the completely revised and expanded new edition of the bestselling not-for-profit accounting guide.

• Language: English
• Publisher: Wiley
• Release date: Feb 1, 2012
• ISBN: 9781118186602

Book preview

To the millions of volunteers who make the not-for-profit sector and all of its achievements possible.

This edition is dedicated to the memory of Malvern J. Gross Jr., who was the author of the first edition of this text and a significant contributor to many of the subsequent editions. Mal was a retired partner of Price Waterhouse (a predecessor to PricewaterhouseCoopers LLP) and a nationally recognized authority on accounting and financial reporting for not-for-profit organizations. He was chairman of the AICPA Subcommittee on Nonprofit Organizations that wrote the 1978 landmark Statement of Position for Certain Nonprofit Organizations, and of the Accounting Advisory Committee to the Commission on Private Philanthropy and Public Needs. He was a member of the committee that wrote the second edition of Standards of Accounting and Financial Reporting for Voluntary Health and Welfare Organizations, and a coauthor of the Museum Accounting Handbook. He served as an advisor to the Financial Accounting Standards Board in the early phases of its work on setting accounting standards for not-for-profit organizations, and to the New York State Charities Registration Office, as well as an adjunct professor of accounting at Lehigh University, his alma mater. After retirement from Price Waterhouse he was president of a not-for-profit organization, the National Aeronautics Association. Mal passed away in 2010 and is missed by all of us.

About the Authors

John H. McCarthy is the Senior Vice President for Administration & Finance at Northeastern University and a lecturer at Harvard University's Kennedy School of Government. He served as the National Leader of PricewaterhouseCoopers' Education & Nonprofit Practice before his retirement in 2005. He was a coauthor of the sixth and seventh editions of this text. He also is the coauthor of Understanding Financial Statements: A Strategic Guide for Independent College and University Boards, published by the Association of Governing Boards of Universities and Colleges, as well as several publications by PricewaterhouseCoopers including: The Changing Role of the Audit Committee; Leading Practices for Colleges, Universities and Other Not-for-Profit Educational Institutions; A Foundation for Integrity (a 2004 guide for codes of conduct, conflicts of interest, and executive compensation); Meeting the Challenges of Alternative Investments; Understanding Underwater Endowment Funds; and Financial Reporting and Contributions: A Decision Making Guide to FASB Nos. 116–117 (among others). He is a CPA who, for 37 years, served PricewaterhouseCoopers' education and not-for-profit clients, including many of the most prestigious institutions in the United States. He currently serves on several not-for-profit boards. He is a past president of the Massachusetts Society of CPAs, Inc. (MSCPA) and is a two-term member of the Governing Council of the AICPA. He holds a BS from Boston College and an MBA from the University of Michigan Business School.

Nancy E. Shelmon retired in 2010 as a senior partner of PricewaterhouseCoopers LLP. Nancy is a member of the AICPA Not-for-Profit Expert Panel. She is a frequent speaker at AICPA and state CPA conferences on financial reporting and accounting issues affecting not-for-profit organizations. She has been serving education and not-for-profit clients for over 30 years and has been involved with some of the most widely respected organizations in North America. Nancy serves on the Board of Directors of the Los Angeles Urban League and International Medical Corps. In addition to being a CPA, she is also a Certified Fraud Examiner. She holds her accounting degree from the University of Minnesota.

John A. Mattie serves as PwC's National Education and Non-Profit Industry Practice Leader. In that role he coordinates the firm's services to educational institutions (e.g., K–12, colleges and universities, and other for-profit educational providers), as well as other nonprofit organizations including museums, foundations, and associations. John has developed a reputation as a substantive business advisor with the ability to develop practical solutions to complex problems. He has consulted clients on a broad range of business and technical topics, including risk assessment and management, financial accounting and reporting, regulatory matters, strategic planning, and financial management. John is also one of the firm's technical leaders for federal compliance issues and currently serves as PwC's partner representative on the AICPA Government Audit Quality Control Center. He was also appointed to the Financial Accounting Standards Board (FASB) Not-for-Profit Advisory Committee (a selected group of 17 professionals from the not-for-profit sector who will provide input to the FASB on critical technical and reporting issues facing the sector in future years), and also serves as PwC's representative on the AICPA Not-for-Profit Exempt Panel. He is recognized by the firm as an expert on current and evolving board governance, accounting and control matters, and their impact on higher education institutions and other nonprofit organizations. One of the industry's thought leaders, having coauthored numerous publications in the last several years, including Challenges of Enterprise Risk Management in Higher Education, Institutional Oversight: Managing the Challenges of Alternative Investments in the Higher Education Environment, Achieving Goals, Protecting Reputation: Enterprise Risk Management for Educational Institutions, Accounting for Asset Retirement Obligations, and Enhancing the Transparency of Financial Reporting. He is also a frequent speaker at national industry association meetings and roundtables.

Contributors

We also recognize the many past contributions of Richard F. Larkin, who was a coauthor of the fourth, fifth, and sixth editions of Financial and Accounting Guide for Not-for-Profit Organizations. Prior to his retirement from PricewaterhouseCoopers, he served as a technical director for the Education & Nonprofit practice. We are very grateful to Dick for his efforts on prior editions of this guide.

The eighth edition of this Guide represents the collaborative efforts of many PricewaterhouseCoopers professionals who work with our not-for-profit clients throughout the United States. The authors very gratefully acknowledge the contributions of the following PricewaterhouseCoopers partners, directors, and managers to this Guide: Ralph DeAcetis, Nathan Doane, John Edie, Maria Esposito, Martha Garner, Thomas Gaudrault, Katharine Grover, Christopher Harris, Michael Hayes, Brian Huggins, Elizabeth Klucznik, Lee Ann Leahy, Nancy Leparto, Geneva Niederwurst, Anslem Oshionebo, Ann Pike, Emily Rando, Carol Ruiz, Ronald Schultz, Eric Schwartz, Shannon Smith, Gwen Spencer, Jeroen van Paassen, and Laura Zenick. Their assistance has been invaluable.

Preface

The accounting environment has changed dramatically the past 10 years since the last edition of this book, so the authors have substantially revised the Financial and Accounting Guide for Not-for-Profit Organizations to create this eighth edition. Perhaps one of the biggest changes has been the introduction of fair value accounting, which affects the way in which we view and value investments, contributions receivable, and split interest agreements. In addition, the FASB has codified all existing pronouncements which affect how we refer to (and locate) accounting guidance; this is discussed further in a new Introduction. The intent of the authors in the eighth edition is to present a perspective of organizations that have now more fully integrated net asset accounting into their financial reporting. The authors have also attempted to streamline all chapters to the extent appropriate while updating them for the latest professional standards.

Like its predecessors, the eighth edition has several objectives. The first objective is to help not-for-profit organizations better manage their financial resources. This starts with understanding. It is easier to manage what you understand. Financial and accounting principles are often intimidating, but this Guide covers the basics and shows that the principles make sense. The second objective is to help not-for-profit organizations better communicate their financial activities and financial condition to their stakeholders and the public.

A common thread running through the chapters in this edition is the need for greater accountability and transparency in financial reporting by not-for-profit organizations. More than ever before, not-for-profit organizations must be accountable to their stakeholders, including, among many others, donors, lenders, regulators, and sponsors. Adapting to the new environment is a challenge, but one that the most successful not-for-profit organizations will understand and embrace.

The other significant changes to the eighth edition include:

A new chapter on the municipal bond market.

A new introduction that discusses the FASB Codification and how to now find accounting literature.

A new appendix addressing the convergence of International Financial Reporting Standards with U.S. GAAP.

Introduction: Including the FASB Codification

The purpose of this book is to discuss the financial accounting requirements for not-for-profit organizations (NPO). We address basic fund accounting principles, board governance, and income tax requirements. The book addresses in some detail the accounting principles applicable to all NPOs, as well as the use of internal controls in financial accounting and compliance with the rules applicable to financial statements, reporting, and disclosures. It includes a discussion of accounting rules applicable to cash and noncash contributions and pledges as well as to investments and endowments. We have included discussion of a broad range of NPO accounting issues and accounting guidance for specific types of NPOs.

Terminology

The ultimate objective of a not-for-profit organization (NPO) is to meet some socially desirable need or goal of the community or its members. Several key characteristics distinguish NPOs from for-profit or business enterprises:

Contributions of significant amounts of resources from resource providers who do not expect commensurate or proportionate pecuniary return;

Operating purposes other than to provide goods or services at a profit; and

The absence of ownership interests like those of business enterprises.

Not-for-profit organizations are generally subject to the same accounting rules as for-profit entities. However, accounting principles specifically applicable or inapplicable to NPOs present unique accounting challenges. Not-for-profit accounting traditionally relied on numerous sources of guidance:

The Financial Accounting Standards Board (FASB) has issued Statements of Financial Accounting Standards (SFAS), as well as Staff Positions, Interpretations, and Technical Bulletins that are referred to as FASB Staff Positions, FASB Interpretations, and FASB Technical Bulletins, respectively.

The American Institute of Certified Public Accountants (AICPA) has issued Statements of Auditing Standards (SAS) and Statements of Position (AICPA SOP) that provide additional financial guidance to NPOs. In addition, AICPA publishes the Codification of Statements on Auditing Standards (2008). (Auditing standard codifications are cited in this chapter as AU.)

The Governmental Accounting Standards Board (GASB), a private, not-for-profit organization, was formed in 1984 to set accounting and financial reporting standards for state and local governments. These standards include organizations that may be tax-exempt as a not-for-profit organization but are subject to governmental accounting standards due to their affiliation with a governmental entity. An example of this is a hospital or foundation affiliated with a state university system.

The Hierarchy of Generally Accepted Accounting Principles (GAAP)

Auditing Standard Codification §411 (AU §411), when discussing the meaning of present fairly in conformity with generally accepted accounting principles, establishes the hierarchy of generally accepted accounting principles (GAAP). For financial statements of not-for-profit organizations other than governmental entities, the hierarchy is summarized as follows:

Category (a) This category consists of officially established accounting principles, comprising Financial Accounting Standards Board (FASB) Statements of Financial Accounting Standards (SFAS) and interpretations, Accounting Principles Board (APB) opinions, and Accounting Research Bulletins (ARBs).

Category (b) This category consists of FASB Technical Bulletins, as well as American Institute of Certified Public Accountants (AICPA) Industry Audit and Accounting Guides, and AICPA Standard Operating Procedures (SOPs) that have been cleared by FASB.

Category (c) This category consists of AICPA, Accounting Standards Executive Committee (AcSEC) Practice Bulletins that have been cleared by FASB, and consensus positions of the FASB Emerging Issues Task Force (EITF).

Category (d) This category consists of AICPA accounting interpretations and implementation guides (Qs and As) published by FASB staff, and practices that are widely recognized and prevalent either generally or in the industry.

FASB Accounting Standards Codification

The FASB Accounting Standards Codification (FASB ASC) integrates all accounting standards currently within levels (A) through (D) of the GAAP hierarchy into one central, topically organized, electronically searchable site. The GAAP hierarchy has been flattened, and all information within the codification is considered level A (authoritative) GAAP.

Effective July 1, 2009, the FASB ASC became the single source of authoritative U.S. GAAP for periods ending after September 15, 2009. Other accounting standards are superseded; information not included in the codification is now considered to be nonauthoritative.

The codification represented a significant and a major restructuring of accounting standards that affects the day-to-day work of nearly every financial professional who prepares, reviews, or audits financial statements of private-sector organizations. Because a significant portion of the GAAP hierarchy consisted of precodification FASB and AICPA standards that are no longer authoritative, the governmental sector has also felt the impact of the codification.

Private-sector GAAP was a proliferation of thousands of standards established by a variety of standard setters, which resulted in a lack of consistent and logical structure. An explosive increase in recent years of financial reporting guidance compounded the difficulties that preparers and auditors encountered in applying and interpreting GAAP.

Accessing the Codification

The FASB ASC represents a major change in how accounting literature can be researched and accessed. The codification's web site (asc.fasb.org) provides general information about how to use the online research system. An online tutorial is available. A basic view of the codification can be accessed online free of charge on the web site. A subscription service offers a more sophisticated version with high level search and retrieval functions.

The FASB ASC is arranged within topics, subtopics, sections, and subsections. Topics reside in main areas:

Presentation (financial statement presentation matters, e.g., statement of activities, balance sheet).

Financial statement accounts (assets, liabilities).

Equity, revenue, and expenses (specific financial statement accounts, e.g., revenue recognition, contributions, receivables).

Broad transactions (transaction-oriented topics, e.g., business combinations, derivatives).

Industries (accounting unique to an industry e.g., not-for-profit organizations, healthcare organizations).

EXAMPLE: To find information on the GAAP requirements for the statement of activities of a not-for-profit organization, a search could start with either the Presentation or Industries topic. Moving down through the topics and subtopics, either of the following paths would retrieve that guidance:

Presentation: 225—Income Statement; 958—Not-for-Profit Organizations, or

Industry: 958—Not-for-Profit Organizations; 205—Presentation of Financial Statements

FASB encourages organizations to use plain English in their footnotes for broad topic references rather than referring to specific codification standards, which can be a much longer number than the FASB Standard it replaced.

Most people find it easier to review the original statement and then cross-reference to the FASB ASC. For example, SFAS 116, paragraph 4 is contained in FASB ASC 958.605.15 and 720.25.15. It should be noted that the AICPA audit guide, Not-for-Profit Entities—AICPA Audit and Accounting Guide, has been updated with FASB ASC references. Specific accounting guidance promulgated by FASB that is unique to nonprofit organizations includes the following, all of which have been incorporated into the ASC:

SFAS No. 116 (accounting for contributions received and contributions made).

SFAS No. 117 (financial statements of not-for-profit organizations).

SFAS No. 124 (accounting for certain investments held by not-for-profit organizations).

SFAS No. 136 (transfers of assets to not-for-profit organization or charitable trust that raises or holds contributions for others).

SFAS No. 153 (exchanges of nonmonetary assets—an amendment of APB Opinion No. 29).

SFAS No. 157 (fair value measurements) and related FASB Staff Position on SFAS 115–1 and SFAS 124–1.

FASB Staff Position 117–1 (endowments of not-for-profit organizations: net asset classification of funds subject to enacted version of Uniform Prudent Management of Institutional Funds Act (UPMIFA) (Prob C §§18501–18510; see §21.71), and enhanced disclosures for all endowment funds).

In general, except as noted above and as noted within the language of any specific pronouncement for accounting, NPOs are subject to the same accounting standards as all organizations.

Throughout this edition, we have chosen to generally use plain English rather than providing ASC references.

Chapter 1

Responsibilities for Fiscal Management

Not-for-profit organizations are among the most influential and powerful institutions in our society. They range in size from small and local to large and national or international. Their scope incorporates a wide range of activity: health and welfare, research, education, religious, social, and professional associations. They include foundations, membership societies, churches, schools, and sports and political organizations. By any measure, not-for-profit organizations comprise a significant share of national income and employ a significant percentage of the national workforce.

All not-for-profit organizations are defined by their mission. Executive management and the board of directors have the responsibility to execute the mission. Financial stewardship is in the care of a financial officer employed by, or who serves as a volunteer for, the not-for-profit organization. The size and kind of organization determines the breadth and depth of the role for the individuals who are assigned fiscal management responsibility. Likewise, the size and kind of organization, and even the laws applicable to its state of incorporation, shape the fiduciary oversight provided by or required by the board.

The descriptive title of the chief fiscal officer varies among organizations. Large organizations may employ a chief financial officer, treasurer, and a director of accounting. Other organizations have a controller, business manager, or accounting manager responsible for financial activities. In a very small organization, a volunteer may be assigned as the treasurer. For the purpose of this chapter, we use the term treasurer to describe the person who assumes responsibility for the fiscal management of the not-for-profit organization.

The treasurer has significant responsibilities:

Keeping financial records for the organization.

Preparing accurate and meaningful financial statements.

Implementing a budget and anticipating financial problems.

Safeguarding financial assets and providing effective internal controls.

Complying with federal and state reporting and regulatory requirements.

Communicating with executive management and the board of directors.

These roles are discussed further in the rest of this chapter.

1.1 Keeping Financial Records for the Organization

The treasurer is charged with the responsibility of properly maintaining the organization's financial records. If the organization is small, the treasurer may oversee the activities of a part-time bookkeeper who records daily, weekly, and monthly transactions using off-the-shelf software or spreadsheet ledgers. Larger organizations have increasingly complex systems and numerous staff hired to maintain accurate financial records. A large accounting staff may include several layers of support staff. Computer systems may be customized or several systems may be integrated to properly record the financial activity.

The treasurer is ultimately responsible for maintaining reliable records. As such, detailed procedures are delegated to others, but the treasurer must determine that procedures are followed and records are accurate. For the small organization, this responsibility may extend to the examination of supporting documentation and asking rigorous questions of the bookkeeper. For the large organization, the treasurer's oversight may be more structured to include regular staff meetings, authority for approval of sensitive transactions, and the review of intermediate accumulated data including the examination of supporting documentation.

Regardless of size, the ultimate responsibility for adequate and complete financial records belongs to the treasurer. This means that the treasurer must have a working knowledge of bookkeeping and accounting concepts. Bookkeeping and accounting are largely matters of common sense and, with the guidance in this book, there should be no difficulty in understanding the basic procedures and requirements necessary for management of a small organization.

1.2 Preparing Accurate and Meaningful Financial Statements

The treasurer has the responsibility to prepare complete and straightforward financial reports for management, for the board and for others, including regulatory authorities and donors, who have an interest in the financial position and the financial activities of the organization. The statement of financial position is equivalent to the balance sheet of a for-profit entity. The statement of activities and changes in net assets is equivalent to the income statement and changes in equity of a for-profit entity. The statement of financial position, the statement of activities (which includes changes in net assets) along with the statement of cash flows are the three basic statements required for not-for-profit organizations. Reports as required under specific accounting and reporting guidance are not the only way to present financial information and may not be the best format to convey financial information to decision makers and others who turn to the treasurer for meaningful, financial reports.

Characteristics of meaningful financial reports include the following:

They should be easily comprehended so that any person of reasonable intelligence, taking the time to study them, will understand the financial picture of the organization.

They should be concise so that the user will not get lost in the detail. The information should be presented in a consistent format each time the reports are prepared.

They should be all-inclusive and embrace all activities of the organization. Individual funds, departments, or account balances should be reported in context of the entire organization.

They should have a focal point for comparison so that the user has some basis for making judgments and understanding the context of the information. The presentation might include comparative information for the current reporting period and period-to-date budget, the annual budget, and the prior-year reporting period.

They should be prepared on a timely basis to encourage timely corrective actions in response to the users' review. Two weeks after an interim month-end and three weeks after year-end are considered appropriate and timely.

Naturally, the reporting particulars for each organization can differ; but the general guidelines as described in the previous list are the foundation for comprehensive comparative reports. The treasurer is encouraged to work directly with users to explain or develop meaningful financial reports.

(a) Nonaccountant Test

Because the purpose of any set of financial statements is to communicate to the reader, a good test of whether they accomplish this objective is the nonaccountant test. Can these statements be clearly understood by any interested nonaccountant of average intelligence who is willing to take some time to study them? After studying them, will he or she have a good understanding of the overall financial activities for the year? If not, then the statements are not serving their purpose and should be revised and simplified until they do meet this test.

1.3 Implementing a Budget and Anticipating Financial Problems

The treasurer is responsible for identifying financial trends and events. The annual budget is a tool prepared by the treasurer as a planning roadmap. A well-developed and carefully prepared budget will provide decision makers with important information about the financial objectives for the year. Upon review of the annual budget or selected budgeted information, the board or management is positioned to take steps to resolve fiscal issues on a timely basis. Preparation of budgets for multiple years is also useful as part of longer-term planning exercises. Based on the budget, the organization may implement actions to increase or decrease staffing, obtain a loan, begin a capital campaign, or reduce discretionary spending.

Generally a budget must be developed in sufficient detail and presented in a format so the users may readily identify the veracity of the budget, including the variable assumptions that were used to develop the budget.¹ Best practice would align the format of the budget in context of the accurate and meaningful financial statements as described in Section 1.2 of this chapter. Furthermore, the treasurer will typically be responsible for explaining variances against the budget throughout the year.

1.4 Safeguarding Financial Assets and Providing Effective Internal Controls

An effective internal control environment provides for the prevention and timely detection of material errors, omissions, or irregularities in the normal course of operations. Thus, an effective internal control environment includes a series of processes and policies that protect the organization from loss and ensure that financial information is accurate. Additionally, the treasurer is responsible for providing physical safeguards to protect assets against unauthorized use or theft and to regularly evaluate the sufficiency of insurance coverage.

Internal accounting controls involve delegating duties and recordkeeping functions that readily identify deviations from authorized procedures. Internal control procedures are also designed to remove undue temptation from employees and volunteers. Best practice requires internal control procedures that are documented in a written policy.²

The system of internal controls should be understood by executive management and the board. Internal controls for a large organization will be regularly tested or monitored and may include an internal audit department that reports directly to the board. Organizations may also include antifraud programs as part of an effective internal control environment.

Included under the umbrella of internal controls and safeguards unique to not-for-profit organizations are the special requirements for accounting for endowment fund assets. State law, donor restriction, or board designation may define the accounting methods that are required when cash is invested or pooled by the organization.³

Executive management, the board, and the donor community look to the treasurer to demonstrate and implement ethical practices and fiscal safeguards for the organization. The internal control environment is a key component of this responsibility.

1.5 Complying with Federal and State Reporting and Regulatory Requirements

The treasurer is charged with compliance under numerous federal and state reporting requirements. Most tax-exempt organizations, other than churches, are required to file annual information returns with the Internal Revenue Service (IRS), and some may also be required to pay tax on unrelated business income. Organizations may be subject to register and file information returns with state governments even if they are not resident in the state. Reporting and filing requirements are complex, and the complexity is increased for ordinary activities typical of many not-for-profit organizations: raffle events, advertising sales, and holding investments in real estate, to name but a few.⁴

Not-for-profit organizations that receive more than $500,000 a year, directly or indirectly, from the federal government are required to implement special accounting and reporting procedures and to have an independent audit in accordance with the regulations under the Office of Management and Budget (OMB), Circular A-133.⁵

Other regulatory requirements are prescribed by the Securities Exchange Commission (SEC) for not-for-profit organizations with public debt. Legislative actions by states, to mirror some of the provisions of the Sarbanes–Oxley Act, may also impose special reporting or filing requirements by the treasurer.

1.6 Communicating Fiscal Information to the Board of Directors and the Audit Committee

The articles of incorporation and bylaws describe how the board of directors of a not-for-profit organization is composed and the legal obligations of its membership. Every board member has a fiduciary responsibility for the affairs of the organization. For some organizations, the board or selected members of the board may act in the role of the audit committee. In fact, as a result of the dramatic changes in corporate America's accounting fraud crimes and investigations in recent years, all SEC registrants are required to have audit committees. Several states have adopted similar legislation, or are in the process of doing so, that requires not-for-profit organization also have audit committees. For example, California requires an organization that has GAAP-basis revenues of $2 million or more (excluding most federal grants) to have an annual audit as well as an audit committee. A sophisticated organization will have an audit committee charter that mandates the following under the purview of its membership:

Overall purpose and objectives of the Audit Committee.

Authority—board authorization of its scope of services.

Organization:

Composition of its membership (only independent directors including, at least, one director familiar with financial reporting).

Nature and frequency of its meetings.

Roles and responsibilities:

Oversight of the internal control environment.

Overall effectiveness of risk management.

Transparency of financial reporting.

Compliance with laws and regulations.

Retention of external auditors and review all services provided.

Supervision of internal auditors.

Oversight of code of conduct and conflict of interest policies.

Effective process for reporting complaints (whistle blowing).

Reporting responsibilities—update the full board on its activities.

Evaluate performance—evaluate committee performance and efficacy of its charter.

Necessarily, management must be independent from the board. However, the treasurer will have a close relationship to the audit committee when communicating financial and other required information. Typically the treasurer will help board members understand and interpret fiscal reports by communicating variances or explanations for activities against the approved budget. For larger organizations the treasurer will prepare a monthly or quarterly fiscal package for timely audit committee review.

Thus, the treasurer is responsible for the day-to-day, week-to-week, and month-to-month fiscal activities of the organization, while the board brings to bear experience and insight from a variety of life's experience. There is a fine balance between board oversight and micromanagement. The best organizations are those with a well-defined charter to help the board exercise its appropriate fiduciary duties in concert with well-defined accounting and reporting policies to guide the responsibilities of the treasurer.

1.7 Ten Key Points to Consider in Not-for-Profit Fiscal Management

(a) Accounting Principles

(i) Not-for-Profit Accounting Is Not Very Different from For-Profit Accounting

Most not-for-profit accounting is no different from for-profit accounting. The primary area which is different for not-for-profit organizations is accounting for contributions. For-profit corporations make gifts, but they do not receive them. Accounting for contributions received, especially pledges, restricted gifts, split-interest agreements, and noncash gifts (gifts-in-kind) is unique and often complicated.⁶

(ii) Not-for-Profit Organizations Must Report Fundraising Expense

Accounting guidelines are very precise about what may be reported and what must be reported as fundraising expense. Donors and watchdog groups pay close attention to fundraising expense as a percentage of total expense. They are eager to know how much of every donated dollar supports programs, fundraising, management, and general expense. Under certain conditions the cost of a fundraising appeal may be shared between fundraising and program expense. Under certain conditions, direct donor benefits may be netted against the cost of a fundraising event. Because this measure is sensitive, a treasurer is well advised to be familiar with accounting rules for recording fundraising expenses.⁷

(b) Financial Reporting

(iii) Audited Financial Reports Are Prepared by Management

Management is responsible for preparing financial reports for an organization, just as management is responsible for keeping the underlying records that support the reports. A complete set of financial reports including notes that contain required disclosures, may be subject to audit procedures as performed by an independent accountant. As a result of the audit, the auditor renders an opinion on the complete set of financial statements as prepared by management. The highest level of assurance the auditor can provide is an unqualified opinion, in contrast to an opinion with an exception, an adverse opinion, or a disclaimer of an opinion. The auditor's opinion is not a guarantee that the financial statements are accurate. Rather, the auditor performs procedures and tests to determine that the financial statements are fairly presented in accordance with the applicable, generally accepted accounting standards in all material respects.

(iv) A Healthy Not-for-Profit Organization Makes Money

While not as important to a not-for-profit as for a business, the excess of revenues over expenses or changes in net assets (the amount in a not-for-profit's financial statements closest to the equivalent of the profit of a business) has significance to management and the governing board of a not-for-profit, and to other readers of the financial statements. For example:

This amount helps assess whether the organization is better or worse off financially at the end of the current year than it was the previous year.

It tells whether the organization lived within its means during the year.

A large negative amount (or continuing smaller negative amounts) could be an early warning sign of financial or management problems.

A large positive amount may indicate that the organization could be doing more to achieve its purpose.

Comparison of the actual to the budgeted amount can indicate the extent to which management engaged in adequate advance planning, and the extent to which the organization's affairs were effectively managed to achieve planned goals.

(c) Budgeting and Resources

(v) A Not-for-Profit Organization Might Budget a Deficit

While a budgeted deficit is not something that should be undertaken lightly or regularly, it should not be dismissed out of hand. Circumstances where this can be appropriate include the following:

The organization has unrestricted net assets in an amount far in excess of needs foreseeable in the near future, and resource providers (members, donors, fee payers, etc.) are questioning the organization's need for additional funding.

The organization is pursuing certain sources of funding that appear likely to come through, and expenditure of certain budgeted expense items can be made contingent on actual receipt of the funding (i.e., if the funding is not received, these budgeted amounts will not be expended).

An immediate need for the organization's services is so important (for example, relief for victims of a disaster) that the board is willing to commit to an activity even though funding is not presently in sight. There are adequate resources to survive in the short term, and the board makes realistic plans for quickly seeking the needed additional funding.

A deficit can be budgeted in one program, if resources to cover the deficit are available from privately funded surpluses in other programs, such as from contributions or endowment income. Funding from federal or government sources generally restrict the use of funds to a specific program for a specific period.

(vi) There Are Three Categories of Endowment Funds: Permanently Restricted, Temporarily Restricted, and Quasi-Endowment Funds as Designated by the Board

⁸

What most organizations call an endowment is really composed of three parts: true endowment, term endowment, and quasi-endowment. The true, or permanent, endowment can never be spent. This endowment is restricted by the donor in perpetuity in accordance with the terms of the contribution. The term, or temporary restricted, endowment can be spent after the passage of time or for a specified purpose. Accounting rules require that temporarily restricted resources be expended, to the extent they are available, prior to the expenditure of unrestricted resources. The quasi-endowment, or board-designated endowment, is legally unrestricted and can be spent at any time as directed by the vote of the governing board. Some organizations fortunate enough to have accumulated large unrestricted endowments may feel uncomfortable admitting to donors that they have such large unrestricted resources. They believe that donors will be less likely to contribute if the true financial picture is known. However, board-designated funds may be clearly described as such even as they must be included with unrestricted net assets. Furthermore, the policy of the board to designate unrestricted net assets may be elaborated in the notes to the financial statements.

A board cannot create a restriction where no donor-imposed restriction exists. A board can designate the unrestricted endowment, it can segregate the assets in a separate investment account, and it can appropriate the assets for some future purpose (such as being held to produce investment income). However, it cannot restrict. Only an outside donor can cause a gift to be reported as temporarily or permanently restricted in the financial statements. Board-designated endowments must be reported as part of the unrestricted net assets. A donor-imposed restriction can only be changed by the donor, if the donor can be located and is willing to modify restriction.⁹

(vii) A Not-for-Profit Organization May Be Required to Consolidate Reporting with Related Organizations

Sometimes, in an attempt to subvert or shield resources from one not-for-profit, a new organization or foundation is created. The requirement to report the related entities in a consolidated report depends on the real nature of the relationship between the organizations. Even if formal legal control does not exist, there may be effective control through overlapping board membership, the parent having the power to appoint board members of the affiliate or to dictate how the affiliate uses its resources. Under certain conditions two related entities may be required to consolidate.¹⁰ If consolidated reporting is not required, the two entities may be considered related parties, and information about the nature of the relationship and transactions with the other organization is required to be included in the footnotes for each organization's financial statements.

(d) Financial Management

(viii) Strong Internal Controls, Antifraud Programs, and an Ethical Tone at the Top Help Deter Fraud for Organizations of Every Size and Kind

Unfortunately, people do steal from organizations that serve the needy. If anything, internal controls are more important to a not-for-profit than to a business because limited resources may be impossible to replace, especially if supporters are not satisfied that the resources are protected from unauthorized use. Failure to establish and monitor an adequate control environment is a certain recipe for failure.¹¹

(e) Government Regulation

(ix) Board Members and Management Are Personally Liable for Unpaid Payroll Taxes Related to Employees of the Not-for-Profit Organization

Small organizations may omit the withholding, reporting, and payment of payroll taxes on behalf of those provided by the organization because employees are improperly classified as contract workers, or when benefits such as certain insurance premiums are omitted from compensation in the determination of an employee's taxable income. If the bookkeeper fails to pay the withheld payroll taxes to the government, the Internal Revenue Service can and will hold board members and managers personally liable for unpaid payroll taxes regardless of a declaration of bankruptcy or the corporate form of organization.

(f) Contributions

(x) A Stringent Gift Policy Is Good Business

Accepting some gifts is a bad business decision. An organization that receives gifts must define a policy to prevent unwanted gifts:

Gifts restricted for a purpose inconsistent with the organization's mission will divert the organization's attention from its priorities.

Gifts with onerous limitations on exactly how the activity must be conducted can result in the recipient's effectively ceding control of its operations to the donor.

Gifts from a donor with a bad public image, and with whom the organization would be embarrassed to be publicly identified, may hurt the organization's fundraising efforts.

Gifts of a building, without adequate provision for paying the ongoing expenses of maintaining and operating the building, can expose the organization to considerable unbudgeted and unfunded liabilities.

Gifts of land under which lies an old toxic waste dump can require the organization to pay for expensive remediation to clean up the waste.

Gifts of an annuity that requires the organization to pay out more than the value of the annuity.

1.8 Conclusion

The treasurer of a not-for-profit organization has a unique opportunity to be part of a social mission while exercising the aptitudes and talents inherent in the discipline of accounting and finance. For volunteers or paid professionals who assume the role of treasurer, the guidance in this volume will assist you in the effective discharge of your important responsibilities.

In addition to this guidance, the treasurer is encouraged to develop networks and relationships with other not-for-profit organizations and trade associations to improve financial understanding and communication. Many professional associations and industry associations have publications, web sites, conferences, and seminars dedicated to education and enrichment for business officers in nonprofit organizations. Other web sites are dedicated to sharing public information about not-for-profit organizations. Keeping abreast of current issues and trends will only enhance the value the treasurer brings to the organization.

Notes

1. For additional information on budgeting, see Chapter 20.

2. For additional information on internal controls, see Chapter 23.

3. For additional information on investment of endowment funds, see Chapter 06.

4. For additional information on reporting and filing tax information, see Chapter 28.

5. For additional information on federal audit requirements, see Chapter 29.

6. For additional information on accounting for pledges and gifts, see Chapter 08.

7. For additional information on fundraising expense, see Chapter 09.

8. For additional information on accounting for unrestricted, temporarily restricted, and permanently restricted net assets, see Chapter 13.

9. A legal procedure, known as cy pres, can lift a restriction, but this is very cumbersome and will not be approved by a court except in very rare cases of extreme financial emergency.

10. Statement of Position 94-3.

11. For additional information on internal controls, see Chapter 24.

Part I

Key Financial Concepts

Chapter 2

Accounting Distinctions between Not-for-Profit and Commercial Organizations

Many businesspeople, as well as many accountants, approach not-for-profit accounting with a certain amount of trepidation because they are unfamiliar with such accounting. There is no real reason for this uneasiness because, except for a few unique areas, not-for-profit accounting follows many of the same principles followed by commercial enterprises. This chapter explores the principal differences and pinpoints these unique areas.

2.1 Stewardship versus Profitability

One of the principal differences between not-for-profit and commercial organizations is that they have different reasons for their existence. Simply stated, the ultimate objective of a commercial organization is to make a net profit for its owners by providing some product or service that people will pay for, whereas the ultimate objective of a not-for-profit organization is to meet some socially desirable need or goal of the community or its members.

Like any organization (or individual), a not-for-profit organization should have sufficient resources to carry out its objectives. However, there is no real need or justification for making a profit—that is, having an excess of income over expenses for a year or having an excess of assets over liabilities at the end of a year beyond what is needed to provide a reasonable cushion or reserve against a rainy day or provide for future growth plans of the organization. A surplus or profit is only incidental.

Not-for-profit organizations have a responsibility to account for funds (which could be in the form of cash, goods, or services) that they have received. This responsibility includes accounting for certain specific contributions that have been given for use in a particular project as well as a general obligation to employ the organization's resources effectively. Emphasis, thus, is placed on accountability and stewardship. To the extent that the organization has received gifts restricted for a specific purpose, it may segregate those resources and report separately on their receipt and disposition. This separate accounting for restricted resources is called fund accounting and is discussed in Chapter 04. While financial statements may be prepared by showing the various funds maintained by the organization, most organizations choose not to do so. Instead, activities are categorized and presented based on their level of restriction (unrestricted, temporarily restricted, and permanently restricted). By grouping activities in this manner, overly complex and voluminous reports can be avoided.

The financial statements of commercial organizations are generally easy to understand, relative to those of not-for-profit organizations, because there is only a single set of statements, the terminology and format are usually standardized and familiar, and accounting principles are more clearly defined.

2.2 Principal Areas of Accounting Differences

There are seven areas where the accounting principles followed by not-for-profit organizations often differ, at least somewhat, from the accounting principles followed by commercial organizations. While the accounting significance of these seven areas should not be minimized, it is also important to note that once the significance of each is understood, the reader will have a good understanding of the major accounting principles followed by not-for-profit organizations. The principal remaining difficulty will then be designing financial statements that reflect these accounting distinctions and are straightforward and easy to understand.

Of the seven areas of differences, only one of them—contributions—is unique to not-for-profit organizations, since businesses do not receive gifts. Thus there are no accounting principles addressing how businesses should account for contributions received. (Accounting for contributions made by for-profit organizations is covered in ASC 958-605 Not-for-Profit Entities—Revenue Recognition issued by the Financial Accounting Standards Board (FASB)—see discussion in Chapter 08.)

The six other areas are not the subject of specific detailed accounting rules, except in certain aspects. As for those aspects, the requirements applicable to not-for-profit organizations are not different from the requirements applicable to for-profit organizations, except for accounting for investments. The differences that exist in practice arise mostly from the differing nature of the way not-for-profit organizations operate and the different concerns of readers of the financial statements of those organizations. In fact, practices followed by not-for-profit organizations are very similar to those followed by for-profit organizations.

That leads to the questions of just what is and is not considered a not-for-profit organization for purposes of deciding what accounting standards an organization is subject to. The American Institute of Certified Public Accountants (AICPA), in its audit and accounting guide for not-for-profit organizations, discusses this issue in its Chapter 01.¹ It refers to a definition published earlier by the FASB, which includes the criteria of (1) receiving contributions, (2) not having ownership interests, and (3) having purposes other than making profit. As to most organizations, it is immediately obvious whether they pass or fail this definition. Businesses fail it on all three counts. Most organizations that we think of as not-for-profit—such as colleges, orchestras, charities, churches, hospitals, and foundations—easily pass it.

There are two types of organizations most people think of as being not-for-profit that do not clearly pass this definition: clubs and associations. They do have purposes other than making a profit, and associations do not have ownership interests. However, many clubs do have ownership interests, and both types typically receive little in the way of contributions—they cover their costs from member dues and from sales of goods and services. (Note that not-for-profit and tax-exempt are not synonymous. Many organizations that are one are also the other, but there are exceptions in both directions.)

Therefore, the question arises as to whether clubs and associations must follow the accounting rules for not-for-profit organizations or the rules for for-profit organizations. The only two accounting areas where there is really any formal difference are investments and functional expenses.

The AICPA's audit guide for Not-for-Profit Organizations resolves this issue by stating that all organizations that were covered by any of the three superseded not-for-profit audit guides (colleges, voluntary health and welfare organizations) are also covered by the new guide. Associations and clubs are also covered by the new guide and should follow the authoritative guidance of ASC 958-605 for valuing marketable investments (see Chapter 08).

In addition, the AICPA's audit guide for Not-for-Profit Organizations excludes governmental organizations from coverage. A governmental organization is defined (in paragraph 1.03) as an organization with one or more of the following characteristics:

Its governing structure is elected by popular vote or appointed (or approved) by governmental officials.

The organization may be unilaterally dissolved by government with the remaining net assets reverting to the government.

The organization can enact and enforce a tax levy.

The organization can directly issue debt, the interest on which is exempt from federal income tax.

This last characteristic may, if it is the only one present, be rebutted.

(a) Cash versus Accrual Accounting

In all but the smallest commercial organizations, the records are almost always recorded on an accrual basis. The accrual basis simply means keeping the organization's records so that in addition to recording transactions resulting from the receipt and disbursement of cash, the organization also records the amounts it owes others and others owe the organization. Some not-for-profit organizations use the cash basis of accounting instead. Cash basis accounting means reflecting only transactions where cash has been involved. No attempt is made to record or accrue unpaid bills owed by the organization or amounts due the organization. Many small not-for-profit organizations use the cash basis, although most of the medium and larger organizations use the accrual basis.

The accrual basis gives a more accurate picture of an organization's financial condition than cash basis accounting. The cash basis is generally used only by smaller organizations that require only basic financial information and may not have the accounting resources necessary to compile financial statements prepared on the accrual basis. Everyone has had experience keeping a checkbook. This is a basic example of cash-basis accounting. A nonaccountant can learn to keep a checkbook, but she or he is not likely to comprehend readily how to keep a double-entry set of books on the accrual basis. Furthermore, the cash basis is often used when the nature of the organization's activities is such that there is no material amounts owed to others, or vice versa, and so there is little significant difference between the cash and accrual basis.

Sometimes not-for-profit organizations follow a modified form of cash-basis accounting, where certain items are recorded on an accrual basis and certain items on a cash basis. Other organizations keep their records during the year on a cash basis, but at the end of the year convert to the accrual basis by recording obligations and receivables. The important thing is that the records kept are appropriate to the nature of the organization and its needs. Chapter 03 discusses cash and accrual accounting.

(b) Fund Accounting

Although in commercial enterprises separate accounting for departments, branches, subsidiaries, product lines, and the like is often done, fund accounting is a term that is not used by most businesspeople and can cause some confusion. In fund accounting, amounts are segregated into categories according to the restrictions placed by donors and designations placed by the organization's governing board on their use. All completely unrestricted amounts are in one fund, all endowment funds in another, all building funds in a third, and so forth. Typically in reporting, an organization using fund accounting presents separate financial statements for each fund. Fund accounting is widely used by not-for-profit organizations because it provides the ability to ensure compliance with legal restrictions, to report on the organization's stewardship of amounts entrusted to it by donors, and to manage operations in accordance with the expressed wishes of the governing board. While this concept of separate funds in itself is not particularly difficult, it can cause problems in presenting financial statements that are straightforward enough to be understood by most readers—that is, to pass the nonaccountant test. Chapter 04 is devoted to a discussion of fund accounting.

(c) Transfers and Appropriations

In not-for-profit organizations, transfers are sometimes made between funds. Unless carefully disclosed, such transfers tend to confuse the reader of the financial statements. Some organizations make appropriations or designations for specific future projects (i.e., set aside a part of the net assets for a board-designated purpose). Transfers and appropriations are not accounting terms used by commercial enterprises. Each is discussed in Chapter 04.

(d) Treatment of Fixed Assets

In commercial enterprises, fixed assets are recorded as assets on the balance sheet, and are depreciated over their expected useful lives. Historically, this has not always been true in not-for-profit accounting, although most not-for-profits have now adopted the business model. Fixed-asset accounting and depreciation are discussed in Chapter 05.

(e) Contributions, Pledges, and Noncash Contributions

In commercial or business enterprises, there is no such thing as a pledge, or a promise to contribute. If the business is legally owed money, that amount is recorded as an account receivable. A pledge to a not-for-profit organization may or may not be legally enforceable; even if the pledge is technically enforceable, the organization may (for public relations reasons) have a policy of not taking legal action to attempt to enforce unpaid pledges. Some not-for-profit organizations record pledges because they know from experience that they will collect them. Others do not because they feel they have no legally enforceable claim. A related problem is where and how to report both restricted and unrestricted contributions in the financial statements. Contributions and pledges are discussed in Chapter 08.

Noncash contributions include donations of securities, equipment, supplies, and services of volunteers. Commercial enterprises seldom are recipients of such income. When and at what values it is appropriate to record such noncash contributions is discussed in Chapter 08.

(f) Accounting for Investments

With the issuance of ASC 958, Not-For-Profit Entities—Investments, not-for-profit organizations have moved closer to the fair value approach to valuing equity and debt instruments with readily determinable market values that are used by for-profit entities and consistent with the authoritative guidance of ASC 820, Fair Value Measurements and Disclosures. For-profits are subject to measurement of investments based on the authoritative guidance of ASC 320, Investments—Debt and Equity Securities. Organizations that may operate as not-for-profit organizations but do not pass the definition above follow ASC 320, not ASC 958. Accounting for investments is further discussed in Chapter 26.

(g) Functional Reporting of Expenses

Accounting literature applicable to not-for-profit organizations has long required some degree of functional reporting of expenses (for example, see the discussion in Chapter 12)—whereas accounting literature applicable to businesses is largely silent on this subject. In practice, however, many businesses use a form of expense reporting that is partly functional. The AICPA's audit guide for Not-for-Profit Organizations also requires functional expense reporting for all not-for-profit organizations covered by the guide. Clubs and associations will have to decide case by case whether they believe they pass the definition of not-for-profit. Those that do not pass are not precluded from reporting expenses on a functional basis, and the authors encourage such reporting because they believe it is the most useful to readers of the statements.

2.3 Conclusion

The seven areas just discussed are the principal differences in accounting found between not-for-profit and commercial organizations. While each of these can cause real problems for the casual reader if the statements are not carefully prepared, there are only these seven areas, and often not all of these differences will be present in any given organization. Part of the reason for these differences stems from the different objectives in not-for-profit and commercial organizations. In not-for-profit organizations, accountability for program activities and stewardship is the objective. In commercial organizations, the objective is to match revenue and costs to measure profitability. The treasurer familiar with commercial financial statements should have no difficulty preparing not-for-profit financial statements once the nature of each of these seven areas of accounting differences is understood. If the objectives of financial statements are kept in mind, the treasurer should be able to prepare financial statements that meet the nonaccountant test for clarity and effectiveness in communicating with readers.

Note

1. AICPA Audit and Accounting Guide—Not-for-Profit Organizations (AAG-NPO) (New York: American Institute of Certified Public Accountants, 2010).

Chapter 3

Cash- versus Accrual-Basis Accounting

Chapter 2 discussed that most medium and larger not-for-profit organizations keep their records on an accrual basis—and that some smaller organizations still keep their records on the cash basis of accounting. The purpose of this chapter is to illustrate both bases of accounting and to discuss the advantages and disadvantages of each.

3.1 Cash and Accrual Statements Illustrated

Perhaps the easiest way to fully appreciate the differences between cash and accrual statements is to look at the financial statements of a not-for-profit organization prepared both ways. The Johanna M. Stanneck Foundation is a private foundation with assets of about $200,000. The income from these assets, plus any current contributions to the foundation, is used for medical scholarships to needy students. Exhibit 3.1 shows the two basic financial statements that, in one form or another, are used by nearly every profit and not-for-profit organization—namely, a Statement of Financial Position as of the end of a given period and a Statement of Activities for the period. Exhibit 3.1 shows these statements on both the cash basis and the accrual basis, side-by-side for ease of comparison. In actual practice, an organization would report on one or the other basis, and not both bases, as here.

Exhibit 3.1 Cash-Basis and Accrual-Basis Statements Side-by-Side to Highlight the Differences in These Two Bases of Accounting

As can be seen most easily from the Statement of Financial Position, a number of transactions not involving cash are reflected only on the accrual-basis statements. These transactions are as follows.

Marketable securities are shown at fair value of $190,000 in accordance with ASC 820, Fair Value Measurements and Disclosures and ASC 958, Not-for-Profit Entities—Investments.

Uncollected dividends and accrued interest income at December 31, 20X2, of $3,550 is recorded as an asset on the Statement of Financial Position. Since there were also uncollected dividends and accrued interest income at December 31, 20X1, the effect on the accrual-basis income as compared to the cash-basis income is only the increase (or decrease) in the accrual at the end of the year. In this example, since the cash-basis income from this source is shown as $8,953 and the accrual basis as $9,650, the increase during the year must have been the difference, or $697, and the amounts not accrued at December 31, 20X1, must have been $2,853.

An uncollected pledge at December 31, 20X2, of $2,000 is recorded as an asset on the Statement of Financial Position; because there were no uncollected pledges at the end of the previous year, this entire amount shows up as an increase of income on an accrual basis.

Unpaid expenses of $1,354 at the end of the year are recorded as a liability on the accrual-basis Statement of Financial Position, but on the accrual-basis expense statements they are partially offset by similar items unpaid at the end of the previous year.

The federal excise tax not yet paid on 20X2 net investment income is recorded as a liability and as an expense on the accrual basis. The $350 tax shown on the cash-basis expenditure statement is the tax actually paid in 20X2 on 20X1 net investment income. (See Chapter 28 for a discussion of taxes as they affect private foundations.)

Because unrealized gains must be recognized in accrual-basis financial statements, a gain of $3,481 is shown in the accrual-basis column but not in the cash-basis column.

Unpaid scholarships granted during the year are recorded as an obligation. Most of these scholarships will be paid within the following year, but one scholarship has been granted that extends into 20X4. As in the case of the other items just discussed, it is necessary to know the amount of this obligation at the prior year end and to take the difference into account in order to relate accrual-basis scholarship expenses to cash-basis expenditures.

As a result of these noncash transactions, there are significant differences in the amounts between the cash and accrual basis. On the cash basis, expenditures of $17,600 for scholarships are shown, compared to $21,800 on the accrual basis; excess of income of $3,258, compared to $3,987; and a fund balance (net assets) of $200,135, compared to $209,166. Which set of figures is more appropriate? In theory, the accrual-basis figures are. What then are the advantages of the cash basis, and why might someone use the cash basis? An explanation follows.

(a) Advantages of Cash Basis

The principal advantage of cash-basis accounting (as previously stated in Chapter 02) is its simplicity and the ease with which nonaccountants can understand and keep records on this basis. The only time a transaction is recorded under this basis of accounting is when cash has been received or expended. A checkbook may be all that is needed to keep the financial records of the organization. When financial reports are required, the treasurer just summarizes the transactions from the checkbook stubs. This sounds almost too easy, but a checkbook can be an adequate substitute for formal bookkeeping records provided a complete description is recorded on the checkbook stubs. The chances are that someone with no bookkeeping training could keep the records of the Johanna M. Stanneck Foundation on a cash basis, using only a checkbook, files of paid bills, files on each scholarship, and the like. This would probably not be true with an accrual-basis set of books.

Another reason organizations often keep their records on a cash basis is that they feel uneasy about considering a pledge receivable as income until the cash is received. These organizations frequently pay their bills promptly and, at the end of the period, have very little in the way of unpaid obligations. With respect to unrecorded income, because they consistently follow this method of accounting from year to year, the net effect on income in any one year is not material. Last year's unrecorded income is collected this year and tends to offset this year's unrecorded income. The advocates of a cash basis of accounting say, therefore, that they are being conservative by using this approach.

For organizations that choose to present their financial statements on the cash basis, a question often arises as to what, if any, footnotes and other